Supply and Demand

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• published: 16 Jul 2012
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http://economicsdetective.com/ If you've only heard of one economics concept, it's probably supply and demand. Eventually we'll want to derive this concept from basic assumptions about utility and cost functions, but for now I'll just go through the 2-minute version. Let's start with supply. A supply curve is a relationship between the price of a certain good, and the amount of that good producers make. Let's say they're producing umbrellas. Supply curves typically slope upwards, since a higher price means producers can earn more from each item they sell, so it's worth it for them to produce more of that item. Now, on to demand. A demand curve is a relationship between the price of a certain good, and the amount of that good buyers want to buy. Although there are exceptions, most demand curves slope downwards. Intuitively, you'll buy more of something if it's cheaper. If we graph our supply curve and our demand curve together, we get this cool little X. The price at which supply and demand cross is the market-clearing price. If the price is at the market-clearing level, producers produce exactly as many umbrellas as as buyers want to buy, so every umbrella is sold, and everyone who wants to buy an umbrella can do so. What if the price of umbrellas is higher than the market-clearing price? Then producers make more umbrellas than buyers are willing to buy at that price, and we have a surplus. Similarly, if the price of umbrellas is set below the market-clearing price, buyers want to buy lots of umbrellas, but producers aren't so eager to produce that many, so there is a shortage of umbrellas. It's important to realize that the words "surplus" and "shortage" always refer to price-phenomena. 1000 umbrellas could constitute a surplus if the price of an umbrella is $100, or it could constitute a shortage if the price of an umbrella is $1. Where would we expect to see prices in our supply and demand model? The answer depends on many things. It depends on whether there is one producer or many, on whether there is one buyer or many, on what the laws are, and on how quickly the market can react to a sudden rain storm.